sub10963_fm.

qxd

4/5/13

11:40 AM

Page xiii

CONTENTS

IN

BRIEF

CHAPTER 1

Overview of Financial Statement Analysis

CHAPTER 2

Financial Reporting and Analysis

CHAPTER 3

Analyzing Financing Activities

CHAPTER 4

Analyzing Investing Activities

CHAPTER 5

Analyzing Investing Activities: Intercorporate Investments

CHAPTER 6

Analyzing Operating Activities

CHAPTER 7

Cash Flow Analysis

CHAPTER 8

Return on Invested Capital and Profitability Analysis

CHAPTER 9

Prospective Analysis

CHAPTER 10

Credit Analysis

CHAPTER 11

Equity Analysis and Valuation

66

132
226
274

338

416
460

506

542
616

Comprehensive Case: Applying Financial Statement Analysis

650

Appendix A Financial Statements A

Colgate Palmolive Co. A1
Campbell Soup A46
Interest Tables
References
Index

I1

R1

IN1

xiii

sub10963_fm.qxd

4/5/13

11:40 AM

Page xiv

CONTENTS

Concept of Income

1 Overview of Financial
Statement Analysis 2
Business Analysis

Introduction to Business Analysis 4

Types of Business Analysis 8
Components of Business Analysis 10

Financial StatementsBasis of
Analysis 15
Business Activities 15
Financial Statements Reflect Business
Activities 19
Additional Information 26

Financial Statement Analysis

Preview 27
Analysis Tools 27
Valuation Models 40
Analysis in an Efficient Market

Book Organization

44

97

Introduction to Accounting
Analysis 106
Need for Accounting Analysis 106
Earnings Management 108
Process of Accounting Analysis 112
114

3 Analyzing Financing
Activities 132
Debt Financing

134

Accounting for Debt 135

Debt-Related Disclosures 138
Analyzing Debt Financing 138
Protections 142

68

Statutory Financial Reports 68

Factors Affecting Statutory Financial
Reports 70

Leases

Nature and Purpose of Financial

Accounting 75
Desirable Qualities of Accounting
Information 75
Important Principles of Accounting
Relevance and Limitations of
Accounting 77

97

Understanding Fair Value Accounting

Considerations in Measuring Fair
Value 100
Analysis Implications 103

Earnings Quality

2 Financial Reporting and

Analysis 66

76

AccrualsCornerstone of
Accounting 79
Accrual AccountingAn Illustration 80
Accrual Accounting Framework 81
Relevance and Limitations of Accrual
Accounting 84
Analysis Implications of Accrual
Accounting 88

xiv

Fair Value Accounting

Appendix 2A:

46

Reporting Environment

91

Economic Concepts of Income 92

Accounting Concept of Income 93
Analysis Implications 95

145

Accounting and Reporting for Leases 146

Analyzing Leases 150
Restating Financial Statements for Lease
Reclassification 154

Contingencies and
Commitments 156
Contingencies 156
Commitments 158

Off-Balance-Sheet Financing
Off-Balance-Sheet Examples

Shareholders Equity

159

159

166

Capital Stock 167

Retained Earnings 170
Book Value per Share 172
Liabilities at the Edge of Equity

174

sub10963_fm.qxd

4/5/13

11:40 AM

Page xv

Contents

Shareholders Equity Reporting

under IFRS 177
Appendix 3A:

Disclosures for Investment

Securities 281
Analyzing Investment
Securities 281

Lease Accounting and

AnalysisLessor 178

Equity Method Accounting

Appendix 3B:
Postretirement Benefits

179

Appendix 3C:
Accounting Specifics for
Postretirement Benefits

Business Combinations

4 Analyzing Investing
Activities 226
Introduction to Current Assets 228

Prepaid Expenses

Inventories

229

234

Inventory Accounting and Valuation

Analyzing Inventories 236

234

Introduction to Long-Term
Assets 243

Plant Assets and Natural

Resources 245
Valuing Plant Assets and Natural
Resources 246
Depreciation 246
Analyzing Plant Assets and Natural
Resources 250

Intangible Assets

254

Accounting for Intangibles 254

Analyzing Intangibles 255
Unrecorded Intangibles and
Contingencies 256

Asset Revaluations under

IFRS 258
Accounting Treatment 258
Revaluation Disclosures 259
Analysis Implications 260

5 Analyzing Investing
Activities: Intercorporate
Investments 274
Investment Securities
Accounting for Investment
Securities 277

276

Derivative Securities

299

Defining a Derivative 300

Accounting for Derivatives 300
Disclosures for Derivatives 303
Analysis of Derivatives 303

234

Accounting for Long-Term Assets

Capitalizing versus Expensing:
Financial Statement and Ratio
Effects 245

288

Accounting for Business

Combinations 289
Issues in Business
Combinations 293

196

Cash and Cash Equivalents

Receivables 230

284

Equity Method Mechanics 285

Analysis Implications of Intercorporate
Investments 287

243

The Fair Value Option

307

Fair Value Reporting

Requirements 307
Fair Value Disclosures 307
Analysis Implications 310

Appendix 5A:
International Activities

311

Appendix 5B:
Investment Return Analysis

320

6 Analyzing Operating
Activities 338
Income Measurement

340

Income ConceptsA Recap 340

Measuring Accounting Income 341
Alternative Income Classifications
and Measures 342

Nonrecurring Items

347

Extraordinary Items 347

Discontinued Operations 349
Accounting Changes 351
Special Items 354

Revenue Recognition

361

Guidelines for Revenue

Recognition 362
Analysis Implications of Revenue
Recognition 364

Deferred Charges

366

Research and Development 366

Computer Software Expenses 369
Exploration and Development
Costs in Extractive Industries 369

xv

sub10963_fm.qxd

xvi

4/8/13

5:33 PM

Page xvi

Contents

Supplementary Employee
Benefits 370
Overview of Supplementary Employee
Benefits 370
Employee Stock Options 371

Interest Costs

377

378

Accounting for Income Taxes 378

Income Tax Disclosures 382
Analyzing Income Taxes 382

Appendix 6A:
Earnings per Share: Computation
and Analysis

385

Accounting for Employee

Stock Options 389

416

Statement of Cash Flows

418

Relevance of Cash 418

Reporting by Activities 419
Constructing the Cash Flow
Statement 419
Special Topics 424
Direct Method 425

Analysis Implications of Cash

Flows 427
Limitations in Cash Flow
Reporting 427
Interpreting Cash Flows and Net
Income 427

Analysis of Cash Flows

Components of Return on Invested

Capital 463
Defining Invested Capital 464
Adjustments to Invested Capital and
Income 465
Computing Return on Invested
Capital 465

Analyzing Return on Net Operating

Assets 470

Appendix 6B:

7 Cash Flow Analysis

Importance of Return on Invested

Capital 462
Measuring Managerial Effectiveness 462
Measuring Profitability 463
Measure for Planning and Control 463

Interest Computation 377

Interest Capitalization 377
Analyzing Interest 377

Income Taxes

8 Return on Invested
Capital and Profitability
Analysis 460

Analyzing Return on Common

Equity 478
Disaggregating the Return on Common
Equity 479
Computing Return on Invested
Capital 481
Assessing Growth in Common
Equity 485

Appendix 8A:
Challenges of Diversified
Companies 486

9 Prospective Analysis

429

Case Analysis of Cash Flows of

Campbell Soup 430
Inferences from Analysis of Cash
Flows 430
Alternative Cash Flow Measures 431
Company and Economic
Conditions 432
Free Cash Flow 433
Cash Flows as Validators 434

Specialized Cash Flow

Ratios 434

The Projection Process

506
508

Projecting Financial Statements 508

Application of Prospective Analysis
in the Residual Income Valuation
Model 515
Trends in Value Drivers 518

Appendix 9A:
Short-Term Forecasting

10 Credit Analysis

520

542

Section 1: Liquidity 544

Liquidity and Working
Capital 544

Cash Flow Adequacy Ratio 434

Cash Reinvestment Ratio 435

Appendix 7A:
Analytical Cash Flow Worksheet

Disaggregating Return on Net Operating

Assets 470
Relation between Profit Margin and Asset
Turnover 471

435

Current Assets and Liabilities

Working Capital Measure of
Liquidity 546

545

sub10963_fm.qxd

4/5/13

11:40 AM

Page xvii

Contents
Current Ratio Measure of Liquidity 546
Using the Current Ratio for Analysis 548
Cash-Based Ratio Measures of
Liquidity 552

Operating Activity Analysis of

Liquidity 553
Accounts Receivable Liquidity
Measures 553
Inventory Turnover Measures 555
Liquidity of Current Liabilities 558

Additional Liquidity Measures 559

Current Assets Composition 559
Acid-Test (Quick) Ratio 559
Cash Flow Measures 559
Financial Flexibility 560
Managements Discussion and
Analysis 560
What-If Analysis 560

Section 2: Capital Structure and

Solvency 563
Basics of Solvency 563
Importance of Capital Structure 563
Motivation for Debt Capital 565
Adjustments for Capital Structure
Analysis 567

Capital Structure Composition and

Solvency 568
Common-Size Statements in Solvency
Analysis 569
Capital Structure Measures for Solvency
Analysis 569
Interpretation of Capital Structure
Measures 571
Asset-Based Measures of
Solvency 571

Earnings Coverage

572

Relation of Earnings to Fixed

Charges 572
Times Interest Earned Analysis 576
Relation of Cash Flow to Fixed
Charges 578
Earnings Coverage of Preferred
Dividends 579
Interpreting Earnings Coverage
Measures 580
Capital Structure Risk and Return 581

Appendix 10A:
Rating Debt

582

Appendix 10B:
Predicting Financial Distress

584

11 Equity Analysis and

Valuation 616
Earnings Persistence

618

Recasting and Adjusting

Earnings 618
Determinants of Earnings
Persistence 623
Persistent and Transitory Items in
Earnings 625

Earnings-Based Equity
Valuation 628
Relation between Stock Prices and
Accounting Data 628
Fundamental Valuation Multiples 629
Illustration of Earnings-Based
Valuation 631

Earning Power and Forecasting for

Valuation 633
Earning Power 633
Earnings Forecasting 634
Interim Reports for Monitoring and
Revising Earnings Estimates 637

Comprehensive Case:
Applying Financial
Statement Analysis 650
Steps in Analyzing Financial
Statements 652
Building Blocks of Financial
Statement Analysis 654
Reporting on Financial
Statement Analysis 655
Specialization in Financial
Statement Analysis 655
Comprehensive Case:
Campbell Soup Company 656
Preliminary Financial Analysis 656
Sales Analysis by Source 656
Comparative Financial
Statements 658
Further Analysis of Financial
Statements 659
Short-Term Liquidity 667
Capital Structure and Solvency 670
Return on Invested Capital 671
Analysis of Asset Utilization 675
Analysis of Operating Performance
and Profitability 676
Forecasting and Valuation 679

xvii

sub10963_fm.qxd

xviii

4/5/13

11:40 AM

Page xviii

Contents
Summary Evaluation and
Inferences 684
Short-Term Liquidity 685
Capital Structure and Solvency 685
Return on Invested Capital 685
Asset Turnover (Utilization) 685
Operating Performance and
Profitability 685
Financial Market Measures 686
Using Financial Statement
Analysis 687

Appendix A:
Financial Statements A
Colgate Palmolive Co. A1
Campbell Soup A46

Interest Tables
References
Index

IN1

R1

I1